Introduction

Last week, Governor Gavin Newsom of California affixed his signature to Senate Bill 54, christened as the Fair Investment Practices by Investment Advisers (referred hereinafter to as the “FIPIA”). This legislative enactment mandates “venture capital companies” with substantial connections to California to gather and annually disclose demographic details concerning the “founding team members” associated with the companies in which they invested the preceding year.

Who All is Covered?

The FIPIA mandates “venture capital companies” meeting the criteria as “covered entities” to adhere to novel reporting prerequisites.

So, let’s first understand, what is the meaning of  “venture capital company” under this regime. In simple words, an entity meeting at least one of the following three criteria:

1. on at least one occasion during the annual period since its initial capitalization, and on at least one occasion during each subsequent annual period, at least 50% of its assets (excluding short-term investments pending long-term commitment or distribution to investors) are venture capital investments, valued at cost;
2. qualifies as a “venture capital fund” under the Investment Advisors Act; or
3. qualifies as a “venture capital operating company” under the Employee Retirement Income Security Act.

Secondly, LexDiscuss?when is a “venture capital company”  considered as a “covered entity”? If it has a substantial nexus to California and satisfies at least one of the following two criteria:

1. manages assets on behalf of third-party investors (including, but not limited to, investments made on behalf of a state or local retirement or pension system) or
2. primarily engages in the business of investing in, or providing financing to, startup, early-stage, or emerging growth companies. Nexus can be established by satisfying any of the following criteria:
   • being headquartered in California;
   • having a significant presence or operational office in California;
   • making venture capital investments in businesses located in, or with significant operations in, California; or
   • soliciting or receiving investments from a person who is a resident of California.

What constitutes a “venture capital investment”?

The acquisition of securities in an operating company in which the investment adviser, the entity advised by the investment adviser, or an affiliated person either has or obtains management rights.

Who Can be considered as “founding team member”?

An individual who either:

1. owned an initial interest in the business, contributed developmentally and/or conceptually to the business before initial shares were issued, and was not a passive investor; or
2. the total amount of money deployed in “venture capital investments” during such period.

Reporting Requirements Under the FIPIA

The FIPIA obligates “covered entities” to annually furnish to the California Civil Rights Department (“CRD”) the cumulative demographic statistics for the “founding team members” associated with the companies in which they invested in the preceding year.

This information will be collected through a standardized survey to be established by the CRD.

What demographic information is necessitated to be collected and reported?

First, the demographic information to be collected includes gender identity, race, ethnicity, disability status, sexual orientation, veteran status, and whether the individual is a resident of the State of California. “Founding team members” are permitted to abstain from the survey, but any refusal to participate must also be reported to the CRD on an aggregate and anonymized basis.

Secondly, the FIPIA also necessitates publication for the prior year,

1.  the number of “venture capital investments” made in businesses whose “founding team members” are predominantly “diverse founding team members,” as a percentage of the total number of “venture capital investments” during such period; and
2.  the total amount of money deployed in “venture capital investments” during such period.

Implementation Timeline

Reporting obligations under the New Diversity Reporting Law are set to begin on March 1, 2025, with “covered entities” required to report information for investments made during the 2024 calendar year.

However, as per many industry experts the timeline for implementation is expected to be delayed. Even, Governor Newsom remarked that the bill “contains problematic provisions and unrealistic timelines that could present barriers to successful implementation and enforcement” and announced that his administration would propose cleanup language as part of his 2024-25 budget, which is typically released on or around January 10 and finalized in the summer.

Our Two Cents 

The FIPIA has garnered applause as a pioneering initiative aimed at rectifying the uneven allocation of funding to emerging companies owned by women and minorities. With over 5,700 venture capital firms domiciled in California, a state at the forefront of venture capital investment, the ramifications of this law are predicted to reverberate throughout the entire venture capital landscape in the United States.

However, owing to the expansive purview of the FIPIA, it also encompasses investment entities not conventionally classified as venture capital companies, including private equity funds, co-investment vehicles, family offices, trusts, etc., under specific conditions.

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